FEMA aspects of Private Trusts
Naresh Ajwani Chartered Accountant
This article was printed in the Chamber of Tax Consultants’ Journal in its December 2013 issue.
	Part A – Relevant factors and Background for discussion.
1.	Preface and general observations.
2.	Different factors for considering FEMA provisions.
2.1	Residential status of wealth owner, location of the wealth, and residential status of the heir / beneficiary.
2.2	Transactions.
2.3	Manner of distribution.
2.4	Kinds of trust.
2.5	Place of forming a trust.
2.6	Summary of different factors.
2.7	Ground reality.
2.8	Guiding principle.
3.	Some FEMA and Income-tax rules which are relevant to understand the FEMA issues for a private trust.
3.1	Payment to a non-resident by an Indian resident.
3.2	Creating an interest in favour of a non-resident.
3.3	Liberalised Remittance Scheme.
3.4	Receipt of funds.
3.5	Eligible Investor.
3.6	Returning Indian.
3.7	Foreign Direct Investment (FDI) in an eligible Indian entity.
3.8	Appointment as a trustee.
3.9	Distribution from a discretionary trust.
Sr.	Topic
	Part B – Legal discussion.
4.	Status of a trust.
4.1	Personal status.
4.2	Residential status.
4.3	To summarise.
5.	Transactions relating to trust where there can be FEMA implications.
5.1	Indian resident settlor – Mr. IR.
5.2	Non-resident settlor – Mr. NR.
	Part C – Some practical steps.
6.	Practical steps.
6.1	For Indian resident.
6.2	For non-resident.
7.	Summary.
	Annexure A.
	Annexure B.

 

Part A – Relevant factors and background for discussion:

1. Preface and general observations:

1.1    The subject of private trust is amongst the most complicated subjects. It is not so just under FEMA but also under other laws. There are several reasons for it. One of the issues which gives rise to complexity is - is trust a contract or a person? Under the Indian trust law, a trust is a contract / arrangement. Trust is not a person.

However many times, trust is referred to as a person – not only in general parlance but also under some laws. For example, under SEBI laws mutual fund and venture capital fund is registered as a trust under the Indian Trust Act. However investors can “invest” in it. It is accepted that each law has its own purpose. Treatment under one law may not apply for another law. Therefore it is alright for a trust to be considered as an arrangement under trust law and a person under another law.

For Indian tax purposes, a trust is not considered as an entity. A trustee is taxed as representative assessee.

Under FEMA, there is no clarity on trusts – private or otherwise. Therefore there are many issues. For some purposes (discussed later), a trust is considered as an entity. See para 4 for discussion.

These differences create controversies and at times regulatory arbitrage.

It is acknowledged by the Government too that a trust is an unregulated entity. As the ownership and control can be easily altered, approval for foreign investment in a trust (Venture Capital Fund) is given on a case by case basis. Wherever issues are not clear, approval is not given. (See Annexure A for an extract of the FIPB review report.)

1.2 Another issue which creates difficulties is – ownership of assets and income. A trust creates “split ownership”. A trustee is a “legal owner” and beneficiary is a “beneficial owner”. This is one of the unique features of the trust.

The trust deed lays down the powers, rights and obligations of the trustee and beneficiary. When deciding on an issue, should one consider the status of a trustee or the beneficiary or both?

1.3 A private trust can be used for several purposes. One of the important purposes is holding of assets, and transfer of assets to the next generation (estate planning).

Today assets are held cross border. Foreigners hold assets in India and vice-versa. This gives rise to FEMA issues.

Trust is used for other purposes also like asset protection from undesirable elements, family holding over business, etc. I have discussed the FEMA issues considering the transfer of assets to the next generation.

1.4 For the sake of clarity, the parties involved in a trust are stated below –

Settlor – Person who makes a settlement in a trust (forms a trust) by entrusting assets in a trust. (It refers to the person who wants to transfer assets into a trust. Settlor can be someone else like a professional who forms a trust with nominal funds. Donors are persons who transfer the assets to the trust. For the purpose of this article, “Donor” is a person who gifts funds to a trust. He may or may not be a settlor / trustee / beneficiary.)

(In this article, the words “settlor”, “owner”, and “donor” have been used inter-changeably.) 

Trustee – Person whom the settlor trusts; and to whom the settlor transfers some funds or property to look after for the benefit of the beneficiaries. He is the “legal owner” of assets, is responsible for managing the trust assets and for legal compliance. (A trustee is like a custodian. He has a fiduciary relation with the beneficiary.)

Beneficiary – Person who is entitled to the income and assets of the trust as laid down in the trust deed. The beneficiary may be identified or not. Beneficiary may exist on the date of trust formation or may come into existence in future. (These are usually spouse and children of the settlor. At times the settlor is also the beneficiary.)

(In this article, the words “beneficiary” and “heir” are used interchangeably.)

Outside India, there is a concept of “Protector”. A “Protector” is a person who is expected to protect the beneficiaries. He can ensure whether the trustee is performing as per the trust deed or not.

The settlor, trustee and beneficiary can be individuals or non-individuals.

The respective trust law can have a bearing on the rights of beneficiaries. For example, under the Indian law, the beneficiary has a right to demand his shares from the trustees in case of specific trusts. Whereas under the UK law, I understand that the beneficiary’s rights are not that strong. One will have to consider the trust law as well as the trust deed.

1.5 A trust can be revocable or non-revocable. On formation of trust and revocation of the trust, FEMA provisions should be seen independently.

1.6 I have discussed legal issues in this article. This may appear technical. Therefore at the end, I have taken up some practical issues if persons want to form a trust.

2. Different factors for considering FEMA provisions:

Various factors can affect FEMA provisions. Some of the important factors are as under:

2.1 Residential status of wealth owner, location of the wealth, and residential status of the heir / beneficiary:

A table below briefly illustrates the different situations of owner, assets and beneficiaries.

 

Wealth owner	Assets	Beneficiary / Heir
Indian resident	In and outside India	Resident and Non-resident of India
Non-resident of India